Simple Ways to Get the Most Out of your 401(k)

4 min read • February 28, 2019

30 sec brief

Even if you’re not yet ready to shovel the annual max into your 401(k), there are simple strategies you can use right now to make the most of your 401(k).

A 401(k) can be the most powerful way to save for
retirement. Employers that offer a 401(k) offer lots of automated features that
can make it easy to get going, but there are key steps you can take that will
wring the most value out of a 401(k).

A 401(k) is the tax-advantaged account where you can sock
away the most for your retirement. In 2019, anyone younger than 50 can
contribute up to $19,000 to a 401(k). That’s more than triple what you can save
in an IRA. If you’re at least 50 years old, you can contribute $25,000 to a
401(k) in 2019.

Granted, that’s a lot, but if you’re nervous about your
retirement security, scaling back your spending (maybe downsizing) can free up
money for turbo-saving in your 401(k). And even if you’re not yet ready to
shovel the annual max into your 401(k), there are simple strategies you can use
right now to make the most of your 401(k):

Make sure you qualify
for the maximum match. If you have job-hopped in the past five or so years
your new employer may have automatically enrolled you in the 401(k) plan.
That’s a well-intentioned move to get you saving for retirement. But you need to check how much of your salary
you are contributing. Many employers set the contribution rate at just 3% or so
of salary. That’s not even enough to earn the maximum matching contribution in
many cases.

For instance, it’s common for employers to offer to match a
portion of an employee’s contribution, up to a maximum of 6% of salary. If you
are only contributing 3% you aren’t going to earn the maximum match. Confirm
that your contribution is at least enough to earn the maximum match. That’s the
absolute lowest rate you should consider.

Aim to contribute 15%
of your salary. Earning enough to get the maximum employer match is just
the bare minimum. According to retirement planning pros, what you really want
to aim for is to save 10% of your pre-tax salary. If you want to play it safer,
or you are already in your 30s and have yet to get serious about saving, you
want to get to 15% ASAP.

If you can’t cold-turkey your way to 10% to 15%, hatch a
plan to raise your contribution rate. Some plans offer an “auto-escalation”
feature. Make sure you are signed up. Or create your own plan for increasing
your savings rate. For instance, vow to raise it 2 percentage points every
year, until you reach your target rate. Set a date to make the change; maybe
your birthdate or your work anniversary.

And every time you get a raise, promise yourself to use at
least half of it for retirement savings. For instance, if you get a 5% raise,
increase your 401(k) contribution rate by 2.5 percentage points.

Consider a Roth
401(k). Many 401(k) plans now offer two ways to save: A Traditional 401(k)
or a Roth 401(k). The difference is in when you pay tax. A Traditional 401(k)
is the “original” 401(k). When you make a contribution it reduces your taxable
income for the year, then in retirement every penny you withdraw will be taxed
as ordinary income. With a Roth 401(k) there is no tax break on your
contribution. Your contribution is made from salary that has already been
taxed. In retirement, all money you withdraw from a Roth 401(k) is 100% tax
free. With a Roth you are essentially front-loading your tax bill.

Ask any CPA what’s best, and you will likely be steered to
the Traditional 401(k) because a CPA’s job is to reduce your taxes this year.
But you should think longer-term. Financial advisors increasingly recommend
having at least some 401(k) savings in Roths, as a “tax diversification”
strategy in retirement. Having some tax-free income in retirement can help keep
your tax bill in retirement lower.

If you’ve been saving for years in a Traditional, you might
consider spending a few years contributing to a Roth. Just contact the plan and
tell them where you want current contributions to go.

Find the Right Mix of
Stocks and Bonds. Your 401(k) is all about the long-term. Even if you are 55
your goal should be to build a portfolio allocation strategy that can support
you at least to age 90. If you don’t want to figure out the allocation stuff on
your own, your 401(k) likely offers a simple way to land at a smart mix of
stocks, bonds and cash: a target date retirement fund (TDF).

Each TDF has a specific year in its name. Acme TDF 2030,
Acme TDF 2045 etc. Pick a TDF with a year that is close to when you expect to
retire, That’s it, you’re done. That single TDF will invest in a mix of stocks,
bonds and cash. If you’re in your 20s, 30s and 40s it will tilt more toward
stocks, and in your 50s and 60s will move more of the portfolio into bonds and
cash.

Don’t Overload on Company Stock. Some companies with publicly traded stock, make their
stock available in the 401(k) plan. In years past, many employers made their
matching contribution in company stock. Be careful. It is risky to keep more
than 10% of any investment portfolio in one stock. That’s not a bet against
your employer, it’s smart portfolio risk management.

Hands Off Until
Retirement. A dangerous quirk of 401(k)s is that when you leave a job you
are allowed to cash out your 401(k). That’s typically a really bad move. You
will likely owe a 10% early withdrawal penalty, and income tax if you had a
Traditional 401(k). (Earnings on a Roth 401(k) withdrawal you take out early
will also be subject to tax.) Moreover, money you cash out today is money you
won’t have for retirement.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

About the author

Carla translates business and personal finance concepts into engaging content that helps individuals make more confident choices in how they manage their money.
Her work appears in The New York Times, Money Magazine, Barron's and Consumer Reports.